ECB Said to Urge Weaker Basel Liquidity Rule on Risks

The ECB is seeking to relax the rule -- designed to force banks to hold enough easy-to-sell assets to survive a 30-day credit squeeze -- by expanding the range of eligible securities, aligning the standard more closely with its own collateral arrangements, the people said. Photographer: Hannelore Foerster/Bloomberg

Aug. 28 (Bloomberg) -- The European Central Bank is pushing
global banking regulators to relax a draft liquidity rule so
that lenders can use some asset-backed securities and loans to
businesses in a buffer they must hold against a possible credit
squeeze, according to three people familiar with the talks.

The ECB, backed by the Bank of France, considers a draft
version of the liquidity coverage ratio, or LCR, may hamper
efforts to combat the euro-area debt crisis by curtailing
lending and making it harder for central banks to implement
their monetary policies, said the people, who couldn’t be
identified because the discussions at the Basel Committee on
Banking Supervision are private. They said the ECB stance is
opposed by some other Basel members, including U.S. regulators.

The LCR was drawn up by the Basel group as part of a
package of measures to prevent a repeat of the turmoil that
followed the 2008 collapse of Lehman Brothers Holdings Inc. The
ECB is seeking to relax the rule -- designed to force banks to
hold enough easy-to-sell assets to survive a 30-day credit
squeeze -- by expanding the range of eligible securities,
aligning the standard more closely with its own collateral
arrangements, the people said.

“As central banks have relaxed their rules” during the
debt crisis in the euro area, “the LCR has become more and more
out of sync with central-bank reality,” said Jesper Berg,
senior vice president at Nykredit A/S, Denmark’s biggest
mortgage bank.

‘Very Problematic’

The 212 largest global banks would have had a collective
shortfall of 1.76 trillion euros ($2.2 trillion) as of June 2011
in the assets needed to meet the LCR, according to figures
published by the Basel committee. The ratio is scheduled to take
effect in 2015.

Lenders have warned that a provisional version of the LCR
standard, published in 2010, would force them to cut loans by
making them hoard cash and buy up more government bonds, because
few assets other than sovereign debt would fully qualify.

“The ECB is concerned about its ability to smoothly manage
liquidity in the money markets for the conduct of monetary
policy,” Richard Reid, research director for the London-based
International Centre for Financial Regulation, said by e-mail.

“In the face of the ongoing euro problems, strict
application of the Basel rules on liquidity coverage at this
stage could be very problematic,” Reid said. Pressing ahead
with the LCR “could further restrict the ability of the banking
system to provide much needed credit.”

Unintended Consequences

The Basel committee said last year that it would review the
rule to address any unintended consequences, and is targeting a
deal by January 2013, when central bank and regulatory chiefs
will meet to decide on the plans. The group will attempt to make
headway at a meeting next month.

While a number of regulators favor making some changes to
the LCR, the ECB and Bank of France are among those seeking the
broadest overhaul, the people said.

More closely aligning the LCR with the ECB’s collateral
rules would expand the range and quality of assets that banks
can use to fill up their liquidity buffers, including by giving
some scope for asset-backed securities and banks’ own loans to
businesses to be used.

The ECB is concerned that without an alignment, banks that
borrow funds from the central bank will earmark their best
quality assets to meet the LCR rule, according to two of the
people.

‘Right Direction’

The Frankfurt-based ECB is also concerned that banks’ need
to hoard highly liquid assets may affect the operation of short-term funding markets, they said.

“Expanding the range of eligible securities for the LCR is
a move in the right direction,” Markus Heidinger, a partner
dealing with financial regulation at law firm Wolf Theiss in
Vienna, said by e-mail.

“There is no class of securities which by definition could
not become illiquid and the solution needs to be in risk
spreading,” he said.

The ECB presented its LCR plan during discussions in the
Basel committee’s working groups, including a meeting in New
York this month, according to one of the people. Its arguments
received only limited support, the person said.

There are concerns among some Basel members, including in
the U.S., that far-reaching changes to the LCR may undermine the
effectiveness of the measure, which was drawn up in part to make
lenders less reliant on central bank support in crises, the
people said. Germany’s Bundesbank and Swedish regulators are
also among members skeptical of the ECB proposals, two of the
people said.

‘Superior Performance’

“The ECB accepts as collateral almost anything short of
the CEO’s tie,” said Berg. “The ECB’s superior performance in
the early phase” after the Lehman collapse “can to a large
extent be attributed to its broad collateral framework.”

There is little support in the committee for calls from
banks for either gold or equities to count as eligible assets
under the LCR, the people said, with neither likely to make it
into the final version of the standard. In general, euro-area
regulators are among the more sympathetic to the case for
including some equities.

Officials at the ECB and the Bank of France in Paris
declined to comment.

Equities, Gold

“Including assets such as equities and gold as eligible
for the calculation of liquidity ratios leaves the outcome far
too susceptible to variations in valuation and speculative
movements,” Reid said.

While equities may have been “more liquid in this crisis
when compared to other types of instruments,” that isn’t
necessarily a sign of “inherent stability,” Reid said.

Other nations represented on the Basel committee tend to
have more narrowly targeted aims for amending the list of
eligible assets, the people said. These include a push from
South Africa for easing rules on corporate debt that is rated
higher than the country’s sovereign bonds.

The Bank of England has raised concerns that making banks
hold full LCR buffers from 2015 may hamper efforts to tackle the
euro crisis, two of the people said.

The Basel committee said last year that lenders should be
allowed to draw down their LCR buffers in times of market
stress, so breaching the minimum level of liquid assets they
would normally be expected to hold. The group is still working
on the details of when and how this would function in practice.

Work Needed

Mervyn King, governor of the Bank of England, has also
indicated that he supports some changes to the standard.

“Much work still needs to be done” to ensure that the LCR
is “properly integrated with the regime of liquidity provision
by central banks,” King said in June.

“In current exceptional conditions, where central banks
stand ready to provide extraordinary amounts of liquidity
against a wide range of collateral, the need for banks to hold
large liquid asset buffers is much diminished, and I hope
regulators around the world will take note,” King said.

Regulators in the committee’s working groups have reached a
provisional deal to retain a split in the LCR between assets
that banks can use to meet their entire requirements and those
that can only be used to meet as much as 40 percent, one of the
people said. Under that agreement, technical rules on how
this two-level approach works would be adjusted.

The accord on this point is likely to be endorsed by the
Basel committee at its meeting next month, one of the people
said.

The Basel committee brings together regulators from 27
nations including the U.S., the U.K. and China to coordinate
global bank rules.